Action by Hugh W. McCulloch, on behalf of himself and of other holders of the first mortgage 5 per cent. gold bonds of the Duluth, South Shore Atlantic Railway Company, due January 1, 1937, against the Canadian Pacific Railway Company and others to compel the Duluth, South Shore Atlantic Railway Company to exchange the plaintiff's 5 per cent. bonds for 4 per cent. bonds, and to compel the named defendant to guarantee interest thereon, and for other relief.
NORDBYE, District Judge.
When the Duluth, South Shore and Atlantic Railway Company (hereinafter called the South Shore) was organized by a syndicate in 1886-1887, the Marquette, Houghton Ontonagon Railroad (hereinafter called the Marquette) operated from Nestoria, Michigan, to Marquette, Michigan, and the Detroit, Mackinac Marquette Railway Company (hereinafter called the Detroit) operated from Marquette, Michigan, to Soo Junction, Michigan. The South Shore lines were to extend through that area from Duluth, Minnesota, to Sault Ste. Marie, Michigan. Consequently, the organizers of the South Shore took two steps to include the Marquette and Detroit facilities within the South Shore system: First, they purchased the insolvent Detroit road outright at a foreclosure sale; second, they obtained a perpetual lease of the entire Marquette road from the Marquette Board of Directors on April 15, 1887. Although the Marquette stockholders were not consulted, they did not object to the arrangement at any time.
$1,427,500 Marquette 8's maturing in 1892 576,000 Marquette 6's maturing in 1908 1,500,000 Marquette 6's maturing in 1923 1,400,000 Marquette 6's maturing in 1925 3,278,456 Marquette 6% preferred stock
The perpetual lease and the Detroit properties were transferred to South Shore by its organizing syndicate on or about April 15, 1887. As consideration for these assets, the South Shore gave the syndicate $4,000,000 five per cent fifty-year non-callable South Shore bonds (hereinafter called Fives), 100,000 shares $100 par value South Shore preferred stock, and 120,000 shares $100 par value South Shore common stock. As security for the Fives, South Shore executed a mortgage (hereinafter called the Mortgage of 1887) of which the Central Hanover Trust Company was trustee.
In both the mortgage and the bonds, South Shore covenanted that the Fives would be a lien against all the present and future South Shore property, including South Shore's "right to possess, maintain, and operate the railroads of the Marquette" under the perpetual lease dated April 15, 1887.
On August 2, 1888, one Thomas and one Brice, who were the majority stockholders in the South Shore, transferred a majority of the South Shore stock to the Canadian Pacific Railway Company for $1,975,000. On the same day, four new members were added to the South Shore Board of Directors. Three of these new directors were officers or directors of the Canadian Pacific; the fourth was the Canadian Pacific counsel. By that time, the Canadian Pacific had completed a line to Sault Ste. Marie, Michigan.
Realizing that adjustments must be made, and seeking to stabilize South Shore financially so that its future operations would be guaranteed, Canadian Pacific, the South Shore, and the Marquette entered into a series of transactions on and about July 17, 1890.
First: On or about July 17, 1890, the Marquette and South Shore stockholders and directors rescinded the perpetual lease on the Marquette properties which had existed since 1887. This rescission was made after Mr. Thomas and the Canadian Pacific had purchased a majority of the Marquette stock.
Second: On July 17, 1890, South Shore and Canadian Pacific entered into the Traffic Agreement dated May 27, 1890, which is one of the pertinent contracts or agreements in this case. The object of this agreement was to create a situation which would redound "to the advantage of the parties hereto and of the Marquette Company." In pursuing the purpose of this agreement, South Shore agreed in Article Third to issue First Consolidated four per cent one-hundred year bonds (hereinafter called Fours) "* * * to the amount of not exceeding Twenty million dollars ($20,000,000) par value, in the first instance, secured by a mortgage constituting a valid lien upon all the real and personal property of both the South Shore and the Marquette Companies."
"* * * apply the said bonds to the following purposes, in the following order:
"II. One million four hundred thousand dollars ($1,400,000) to the sole purpose of retiring, at or before maturity, bond for bond, a like amount of Marquette six per cent (6%) mortgage bonds falling due in the year 1925.
"III. So much as may be necessary for that purpose, to retiring the other bonds * * * constituting a lien upon the property of the Marquette Company, at or before their maturity.
"IV. So much as may be necessary to paying off its floating debt and extinguishing the Consolidated mortgage now existing.
And in Article Fifth of the Traffic Agreement, the Canadian Pacific promised that "* * * as fast as the said new four per cent (4%) mortgage bonds are exchanged for any of the said outstanding bonds * * * at par, or as fast as such bonds are issued, exchanged, or sold upon other terms, with the consent in writing of the Pacific Company, the latter company will execute a guaranty, under its corporate seal, upon the new bonds so issued, * * * for the payment of interest thereon, during the entire term thereof, at the rate of four per cent (4%) per annum, payable semi-annually. * * *"
In addition, South Shore and Canadian Pacific agreed that no subsequently authorized bonds would be prior to the Fours and that the "management and workings of all the railways belonging to the South Shore Company and Marquette Company" would be subject to Canadian Pacific supervision whenever Canadian Pacific was required to pay the interest on the Fours in accordance with its promise in Article Fifth. Likewise, Canadian Pacific was entitled to take up the interest coupons which it paid, and South Shore was required not to compete with the Canadian Pacific and to direct all possible business towards it. In addition to these promises, Canadian Pacific was to receive, and did receive some time after May 1, 1892, $2000,000 of Fours.
Third: On July 17, 1890, South Shore and Marquette executed an Agreement of Sale with respect to the Marquette properties. This agreement provided that the South Shore would become the outright owner of all the Marquette "railway and other property, real and personal." As consideration, South Shore promised to assume liability on the outstanding Marquette bonds and to retire them by using an equal amount of the Fours upon which Canadian Pacific had promised to guarantee the interest. South Shore further promised to exchange the outstanding Marquette stock for Fours and to retire all of its own outstanding bonds, including Fives, so that the Fours upon which Canadian Pacific would guarantee the interest would be the only outstanding South Shore bond obligations.
Fourth: The other transactions of July 17, 1890, consisted of South Shore's executing a mortgage (hereinafter called the Mortgage of 1890) as security for the Fours. It provided for their issuance, and that the Fours were a lien on all South Shore and Marquette properties.
The Traffic Agreement and the other transactions of July 17, 1890, continued without cancellation or modification until May 22, 1936. On that date, South Shore and Canadian Pacific executed the "Supplement to the Traffic Agreement dated May 27, 1890" (hereinafter called Traffic Agreement Supplement). It modified the Traffic Agreement by releasing South Shore from its obligation to issue the Fours and by releasing Canadian Pacific from its obligation to guarantee the interest on any Fours except those issued prior to May 22, 1936. The Traffic Agreement Supplement provided that: "All provisions of said traffic agreement of May 27, 1890, which required the South Shore Company to issue and apply bonds under said Mortgage for the purposes stated in said agreement, and any provisions thereof which required the Pacific Company to execute a guaranty of interest upon said bonds, are hereby abrogated and shall be of no further effect, except with respect to such bonds as have heretofore been issued, guaranteed, and applied as aforesaid, and the South Shore Company shall promptly revoke the authority of the Trustee under said Mortgage in excess of the amount now outstanding thereunder, and shall take appropriate steps to close said Mortgage."
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